Cryptocurrencies – a timely reminder of the risks

By June 22, 2023Investments
Graphic of pile of cryptocurrency with a graph line across it

The Financial Conduct Authority (FCA) has recently repeated the warning that investors in cryptocurrency should “be prepared to lose all their money” whilst introducing new rules covering the marketing of crypto assets. We feel this is an appropriate time to highlight the risks associated with cryptocurrencies and why even tighter regulation is likely and warranted.


Tighter restrictions

As part of a package of measures announced by the FCA, crypto firms will, in future, need to ensure that investors have appropriate knowledge and experience to invest in cryptocurrencies before making a purchase. In addition, promotions will need to carry clear risk warnings and any advertising will have to be clear, fair and not misleading. Marketing techniques, such as the offering of bonuses to refer friends will be banned. Finally, from 8th October 2023, individuals who purchase a cryptocurrency for the first time will be provided with a “cooling off” period, to allow them to change their mind about the purchase for a short period after the order has been placed.

Westminster is also keen to see further regulation in the industry. The UK Parliament Treasury Committee called in March 2023 for so-called “unbacked” crypto tokens, i.e. those whose value is not represented by a physical holding in currency such as US dollars, to be regulated in the same way as gambling.


Wider reach of Crypto

Investing in cryptocurrencies has become increasingly popular in the UK, which we feel underlines the importance of the FCA’s announcement. In a survey by Kantar for H M Revenue and Customs in 2022, 10% of UK adults said they hold or have held a crypto asset (this equates to just under 5 million UK citizens). The majority of those questioned said that they had bought crypto currency and have never sold any of their holding. Of those surveyed, 53% of current owners had holdings valued up to £1,000, with 7% holding more than £5,000 in value. Of those surveyed, 76% of holders were under the age of 45, showing the increased uptake of crypto assets by younger investors.


Regulators tighten their grip

Global financial regulators have shown concern over the increasing popularity and reach of cryptocurrencies. In 2021, a comprehensive International Monetary Fund report concluded that cryptocurrencies offer some opportunities for decentralised finance but underlined a number of risks to global financial stability, which include the potential that episodes of poor confidence in crypto assets could spread to mainstream assets, and the risk that cyber security breaches and lack of oversight could disrupt the currently unregulated market. Recent news from the US has added to the notion that the regulators are, perhaps, finally ready to increase regulation.

The US Securities and Exchange Commission (SEC) have recently filed lawsuits targeting two of the world’s largest crypto exchanges – Binance and Coinbase. These relate to alleged rule breaches covering the trading of crypto assets that were not registered as securities by the exchanges. This includes popular tokens such as Cardano and Polygon.

The Commission’s actions have come amidst stark warnings from regulators. SEC Chair Gary Gensler commented that “the entire crypto industry business model is built on non-compliance” and the recent moves are perhaps the clearest signal yet that US regulators’ stance is shifting.

Whilst consumer protection is clearly a high priority, another key reason regulators are keen to introduce tighter restrictions is the lack of Anti-Money Laundering and other due diligence checks carried out on investors. As a result, it is widely believed that many cryptocurrency transactions are illicit. The UK National Crime Agency estimate that over £1bn of illicit cash is transferred overseas each year using crypto and coin exchanges are often used by money launderers.


Increasing risk of fraud

Whenever clients talk about cryptocurrencies, our response has always been the same – investments in cryptocurrencies are unregulated and carry significant risk of total loss of the investment.

It is the unregulated element that concerns us the most. Unlike regulated investments, where investors do have some protection offered under the Financial Services Compensation Scheme if something goes wrong, cryptocurrencies are unregulated, potentially leaving investors without recourse if an investment fails, or funds disappear due to fraud or malpractice. There have been a number of high-profile reports where coin wallets have been stolen by cyber fraudsters and according to research carried out by Chainalysis, hackers stole a record $3.8bn worth of cryptocurrency in 2022. Numbers as large as these only serve to highlight the risks of investing in cryptocurrencies.


Will regulatory oversight be effective?

Regulators around the world are slowly starting to make moves to bring crypto assets under closer scrutiny. We feel the FCA announcement is welcome and as part of the Cryptoasset Taskforce, the FCA aim to work with the Bank of England and Treasury to further assess the potential impact of crypto assets in the UK and with international partners, look to increase co-ordination on regulating cryptocurrencies on a global scale.

We expect to see much greater efforts to regulate crypto assets over coming months and years, as crypto becomes increasingly mainstream, in particular with younger investors. Even if tighter regulation is bought in, we feel the FCA’s reminder of the risks is timely and worth repeating.

Speak to one of our experienced financial planners here if you would like to discuss the above further.